STUMP » Articles » Calpers: Moving Targets, in More Way than One » 23 December 2016, 05:52

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Calpers: Moving Targets, in More Way than One  


23 December 2016, 05:52

There will be no math in this post.

Okay, no additional math beyond what occurs in the stories I quote.

The math can wait til after Christmas.


CalPERS board gives green light to cut assumed rate of return to 7%:

The full CalPERS board approved Wednesday a plan to reduce the pension fund’s rate of return to 7% from the current 7.5% over a three-year period.

The action follows the recommendation of CalPERS’ finance and administration committee Tuesday night.

California Gov. Edmund G. “Jerry” Brown Jr., who in the past has criticized the $303.6 billion California Public Employees’ Retirement System, Sacramento, for having unrealistic investment return assumptions, issued a statement in support of the action.

“Today’s action by the CalPERS board is more reflective of the financial returns they can expect in the future,” Mr. Brown said. “This will make for a more sustainable system.”

The reduction in the rate of return is not as big as was discussed last month. Chief Investment Officer Theodore Eliopoulos said at last month’s finance and administration committee meeting that given diminished investment return assumptions over the next decade, 6% was a more realistic return for the coming 10 years.

Andrew Junkin, president of Wilshire Consulting, which serves as CalPERS’ general consultant, said at the November meeting that Wilshire was predicting an annual return of 6.21% for the next decade, down from its estimates of 7.1% a year earlier.

The change comes as representatives of California cities, towns, school districts and other governmental units that contribute to the nation’s largest defined benefit plan argue that they could not afford the contributions necessary with a lower return rate.

California state Controller Betty Yee, a member of the finance and administration committee, said at Tuesday’s meeting that she can predict the headlines Wednesday. “There will be headlines tomorrow about how we were not aggressive enough,” Ms. Yee said of the 7% rate of return, adding that the reduction will be noted around the world.

But Ms. Yee said the rate reduction will help stabilize the pension fund and added that CalPERS’ falling funding ratio is a symbol of the changing world economy.

CalPERS’ current funding ratio is 68%. Two years of poor results — a 0.6% return for the fiscal year ended June 30 and a 2.4% return in fiscal 2015 — have contributed to a more negative view of what CalPERS can earn over the next decade.

Well, let’s check that.

The most recent “facts at a glance” are as of June 30, 2015:

Well, the 20-year returns aren’t too bad. And even one extra year at 0.6% shouldn’t pull a 20-year average down by a huge amount, right?

Hmmm, but I said there would be no additional math. So I will drop that.

Here is a rude awakening though: the 7% is merely allowing a wee bit of reality in. Even 7 percent is optimistic. CalPERS advisers project the fund will earn on average just 6.2 percent per year over the next decade.:

CalPERS, the nation’s largest public pension system with more than $300 billion in assets and 1.8 million members, faces a series of financial pressures. More workers are retiring and living longer once they do, raising benefit costs and leaving fewer people to pay into the system.

The fund has not recovered from massive investment losses during the Great Recession, which wiped out a quarter of the pension fund’s value. And investment returns have fallen far short of the earnings target – 0.61 percent in the last fiscal year and 2.4 percent the year before.

CalPERS now pays out more each month in benefits to its retired members than it earns from cash and investment earnings. The fund has only enough assets to pay for about 68 percent of promised benefits, and each year of below-target earnings creates a bigger chasm between assets and liabilities.

“Today’s action by the CalPERS Board is more reflective of the financial returns they can expect in the future,” Democratic Gov. Jerry Brown said in a statement. “This will make for a more sustainable system.”

Brown has long warned about the precarious finances in the state’s pension system and urged CalPERS to adopt more realistic assumptions.

The decision will strain the budgets of local governments and require their workers to contribute more, but failing to react to the pension system’s growing unfunded liability would be even worse, said Faith Conley, legislative advocate for the California State Association of Counties.

Phasing in the rate over eight years will give counties time to prepare, she said.

“It’s better now than later,” Conley said. “The next 10 years don’t look that great. So if we don’t do it now, we could suffer a much bigger hit later, and that would be bad for us and employees.”

Remember that the 7.5% return they’ve been using has been used only for a few years now.

According to the Public Plans Database, Calpers was using 8.25% as a discount rate up til 2002, 7.75% from 2003 to 2010, and 7.5% since 2011.

Even with that 7.5% assumption, various municipalities were feeling the pinch. Lowering the rate all the way to about 6% would really bite, so that’s obviously right out…. even if it would be a more realistic valuation.


Now, this isn’t exactly news. I wrote about this before: California Consequences: Turns Out, Pension Benefits Can Be Cut .

But it seems it’s official official now: CalPERS Cuts Pension Benefits For First Time

The unthinkable just happened in Loyalton, California, a small remote city nestled high in the Sierra Nevada Mountains.

For the first time in its 85-year history, the California Public Employees Retirement System, CalPERS, is drastically cutting benefits for public retirees. Starting January 1st, four retired City of Loyalton public employees will have their pensions cut 60 percent. For 71-year-old Patsy Jardin, that means her pension will drop from about $49,000 a year to a little more than $19,000.

In an interview with the FOX Business Network, Patsy asked, “How am I going to make it now? What am I going to do?”

Fellow Loyalton retiree John Cussins is asking the same question since his pension will also drop 60 percent, to $1,523 a month.
John worked about 22 years for the City of Loyalton, Patsy worked there for 34 years. Both of them thought their pensions were safe when they retired since the city had always paid its CalPERS bills in full.

But three years ago, the City Council in Loyalton voted to leave CalPERS in order to save money. At that time, CalPERS informed the city its pension accounts were only 40 percent funded despite the fact Loyalton had paid all its previous bills.

“The City of Loyalton defaulted on their retirees,” CalPERS Deputy Executive Officer Brad Pacheco said. “They made a bad decision and those retirees are going to suffer for it.”

John and Patsy say CalPERS cares more about the 3,000-plus cities towns and municipal entities that pay into the fund than the people the pension fund is supposed to cover in retirement.

Like Loyalton, CalPERS is far from fully funded, only 65 percent. That means right now CalPERS has 65 cents for every dollar that it needs to provide pension benefits for almost two million people.

Some of them are still working and not yet receiving pension benefits. The rest are retired and drawing funds from CalPERS.

Pacheco, the CalPERS spokesperson, told FOX Business network the pension fund is healthy but in a negative cash flow position.

“We are paying out more in benefits than we are taking in in contributions,” he said.

CalPERS pension debt is roughly $164 billion and mostly likely will grow larger in coming years.

A comment from The American Interest:

CalPERS appears to be using Loyalton to send a signal to others considering pulling out of the fund. But neither staying nor leaving is a good option here. Either benefits will be drastically cut or taxes will go up to fund them. The only alternative would be a federal bailout, and with a GOP-controlled Congress and White House, there’s a fat chance of California getting that.

Congress won’t be able to bail them out. But let’s set that aside.

With the reducing of the assumed return on assets/discount rate (which is the same for public plans, more or less), Calpers is going to be asking for higher contributions from the various municipalities. Some of them already have trouble meeting this bill. They may look at the Loyalton alternative and think “well, hell, we can’t really afford these benefits…..”

I wouldn’t assume these Loyalton cuts are going to keep the smaller, really strapped towns in line. I don’t see why they would.


So let’s see what’s a priority for the fund trustees, shall we?

California public pension system to sell all tobacco stocks:

The California Public Employees’ Retirement System decided Monday to sell its last $550 million worth of tobacco-related investments nearly two decades after trading away the bulk of them.

In a 9-3 vote, the CalPERS investment committee disregarded the advice from its own financial advisers who recommended reversing a sell-off of tobacco stock that was approved in 2000, which has cost the system more than $3 billion in lost earnings.

At that time, CalPERS divested tobacco holdings managed by its in-house advisers, but it allowed outside managers to retain the investments they controlled.

Public health organizations overwhelmingly opposed a re-investment, saying it would send the message that California supports a product that causes cancer and raises health care costs.
CalPERS has long taken a dim view of divestment as a strategy to influence public policy, preferring to use its clout as a large investor to pressure companies in which it owns stock. The agency says it is obligated to maximize investment earnings to protect the long-term availability of retirement benefits and minimize costs to taxpayers.

Nonetheless, CalPERS decided in 2000 that mounting pressure from lawsuits and declining rates of smoking justified selling off tobacco-related investments.

Financially, it was a bad bet. In the 15 years since, tobacco was the second-highest performing industry and significantly outperformed the market, CalPERS experts wrote, and investors who didn’t sell off reaped 900 percent cumulative returns.

Investment advisers said a fully diversified portfolio that includes tobacco stocks is the lowest-cost, lowest- risk way to manage the portfolio. But they cautioned that re-investing carries its own risks.

The industry faces growing restrictions around the world on its core tobacco products and on emerging electronic cigarettes, including in California, which is raising taxes and raising the legal smoking age from 18 to 21. Tobacco stocks are also trading at all-time highs and may become less attractive as interest rates come down and investors move money out of high-dividend stocks.

This may be good timing, as they note — these may be top-of-the market times for tobacco stocks.

Of course, some of those tobacco companies may be branching off into some non-tobacco nicotine-type products which could do well in the future. Such as treatments for Parkinsons, schizophrenia, and other neurological problems. Heck if I know. I’m not setting investment policy for a pension fund.

It’s not like tobacco faced fewer restrictions over the 15 years that gave tobacco 900% cumulative returns.

An editorial from the LA Times approves of the move:

The California Public Employees’ Retirement System’s board of administration took a stand in 2000 when it voted to divest from tobacco companies, which profit from a product so toxic that it kills or disables millions of the people who use it. It was the right decision at the time, and remains so 16 years later.

It was also a fairly easy decision back then for the nation’s largest public pension fund. Not only was tobacco killing people, it was costing the state dearly in healthcare expenses and lost productivity. The final nail in the coffin, so to speak, was that tobacco didn’t appear to be a great investment in 2000. The value of tobacco investments had plunged in the previous two years, smoking rates were continuing on a long downward trend and potentially pricey litigation against the industry was pending.

In other words, divestment looked like a classic win-win. CalPERS could take a moral position and not jeopardize its primary duty to make money for the 1.8 million people who rely on it for their retirement. And though there’s no evidence CalPERS divestment affected smoking rates (which were already dropping) or blocked tobacco companies’ access to capital, it was part of successful effort, along with strict regulation, high taxes and ubiquitous anti-smoking campaigns, to “denormalize” tobacco use.

Turns out, though, that tobacco investments didn’t tank as expected, in part of because of expanded marketing in Third World countries. Investors who retained their tobacco holdings realized significant revenue. Analysts estimate that CalPERS lost out on as much $3.68 billion in earnings over the years — about a quarter of what CalPERS’ investments have earned annually over the last decade.

That’s not great news for a severely underfunded pension fund whose poorer-than-expected performance may lead the board this week to lower its expected earnings from investments — again. If the board votes to do so, it would force the state and local governments and school boards in CalPERS to increase their annual pension contributions by millions of dollars, leading them to cut services or raise taxes.

On Monday, the CalPERS Investment Committee is also considering a proposal by staff to allow the $300 billion fund to reinvest in tobacco companies. It must be tempting to chase the revenue that may have been lost from not investing in Camels or Kools, but if there is a return to be made on tobacco (and that’s not even a sure bet), it wouldn’t be worth the moral cost. The board should reject this proposal.

Divestment is a difficult call for governmental pension funds. They have a clear fiduciary duty to maximize the returns on their members’ investments. But in our view, these public agencies also have a responsibility not to support evil, corrupt or destructive forces whose ill effects far outweigh any good they may do. That can take the form of products, like tobacco and firearms, or regimes. The decision by pension funds and U.S. companies to divest from South Africa in the late 1970s and 1980s, for example, is credited by many with helping to raise awareness about apartheid, which led to its ultimate demise.

Yet such moves also increase pressure to divest from more businesses, products and countries for purposes that aren’t necessarily as morally imperative but are politically popular. For example, a bill introduced this month in the state Legislature would restrict CalPERS’ investments in the construction of the Dakota Access Pipeline. It’s not a stretch to imagine a push to divest from soda companies or industries that use genetically altered organisms for food or farming.

That’s a slope CalPERS can’t afford to slide too far down. (The board’s own policies state that it will not divest unless required by valid state or federal law, which seems disingenuous in light of its history on tobacco.) The more constrained the fund becomes, the harder it will be to generate the big returns it’s relying on. And every dollar it falls short will have to be made up by the state and participating local governments, leaving them less money for public safety, anti-poverty programs, educating children and other priorities.

That’s easy for you to say. It’s not your pension benefits at stake (though I guess it is their tax rates at stake, so they have a bit of skin in the game… of course, they can always move away from California taxes. The editorial writers, that is.)

Anyway, what a pile of mush.

Here’s a brief whiff of sanity:

Admittedly, there’s a solid, if heartless, case to be made for reinvesting in tobacco. It’s a legal product, and users can’t credibly claim they didn’t know about the dangers listed right on the pack. And while ever-dwindling smoking rates may eliminate that habit within the next two decades, tobacco companies have found a new source of profits in the growing market for electronic cigarettes.

Here’s an even nastier thing to say: perhaps Calpers should be handing out packs of cigarettes to their retirees, so they don’t live quite so long and strain the funds so much.

But wait, I’ve got even nastier things to say!

The primary cause of death in the U.S. is heart disease, made worse by smoking, to be sure, but far from a majority of people with heart disease ever smoked. But many have been sedentary and are overweight (at the very least). How dare Calpers invest in evil McDonald’s! And technology that allows people to sit on their asses more!


But let’s pull back a moment. I’ve written about the divestment idiocies before, so let’s see what I had to say then:

October 2015: Public Pension Follies: Divestment! Divest from All the Dirty Things!


The danger of divestment is more to the funds which are divesting than the targeted sector. I have no idea if the fossil fuel sector is in structural decline. It may be, in the very long run. Say, a couple centuries. I don’t know. My forecasting of this sort of thing isn’t likely to be good, mainly because we’ve only had about a few centuries experience in this particular area.

But these pension funds have a duration on the order of a few decades (maybe…some are shorter).

The last link, from 2007, gives four reasons that divesting a whole group (in this case, companies that do business with Sudan, Iran, etc.) can be problematic. I think it unlikely any of these trustees will be sued for breach of fiduciary duty, especially when non-fiduciaries (i.e. the politicians) remove choice from them.

But the issue is that public pension funds are desperate for investment income. They’ve been scraping for it in private equity and hedge funds, as well as any growth sector they can. Calpers and others have lost a great deal of money on “green” investments, and this seemed like a good gig as long as the money keeps rolling in from taxpayers, plugging any holes.

But if that money isn’t forthcoming….

November 2015: A Week of Bad Pension Ideas: Finally, Divestment


If you hang onto a losing stock, then yeah, you can lose even more. Various fossil fuel stocks have been down lately, and I don’t think one can only chalk it up to political pressure. New capacity had been brought on line, and some economies, such as China, are not growing as fast as once they were. So the demand growth is less than the supply growth.

(I could be wrong about the above… I don’t have time to look into it for now.)

But fundamental analysis isn’t why the California legislature is forcing the pensions to dump their coal investments. And in any case, it’s highly inappropriate for legislators to be legislating every damn little jot and tittle in pension assets (privatize public pensions now!)

It sounds like previous divestment pushes have hurt the pensions:

“One consultant pegs the capital loss associated with all past CalPERS divestments (in tobacco and firearm manufacturers as well as other politically incorrect investments in South Africa, Iran, Sudan and some emerging markets) at $4 billion to $8 billion, putting California’s indulgence of anti-coal sentiments in an entirely new light.”

April 2014: Public Pensions and Blacklists: Harmful to the Pensions

One particular episode stands out for me, when the Calpers CIO made a dismissive remark about the amount of money Calpers had lost on “green” investments. Hundreds of millions lost. Oh, but that wouldn’t come up in a ranking of asset managers – after all, he lost money on a good cause.

Oh, and here’s a puff piece about Joe Dear cleaning up Calpers. Yes, the man is now dead from cancer and nil nisi bonum and all that, but he had his chance.

Because this is what he said in 2013

‘A top official with California’s public employee pension system admitted this week that its holdings in green energy companies have lost hundreds of millions of dollars.

‘Joseph Dear, the chief investment officer of the California Public Employees’ Retirement System, called its green energy investments “a noble way to lose money.”’

Isn’t that nice for him.

I understand that many of the politically connected see these huge pots of money and can throw a lot of fees, etc., to their favored people and causes. This is the main reason why I changed my mind about privatizing Social Security or trying to invest the SocSec Trust Fund in securities (ignoring for a moment that the Trust Fund is entirely fictional).

Similarly, from last year, Calpers shot itself in the foot by divesting from gun manufacturers.

These decisions were made on a purely political basis. And they hurt the financial performance of the pension funds.

I’m sure all these political actors think that the taxpayers (or bondholders) will make the pensions whole. That they’ll be able to guilt the people (whose money they took and played with to feel good about themselves) into having pity on the poor pensioners.

So I am telling you, public employee unions, your “friends” are some of the very people who are undermining your pension security, far more than the groups explicitly lobbying for pension reform. In general, the reform groups look to attack future accruals, not past benefits earned.

But the public pension investment shenanigans?

Those threaten benefits even currently being paid.

I am not serious about handing out cigarette packs to Calpers retirees.

But I am serious that the pension fund trustees should stop focusing on “good” and “evil” when making their investment decisions. It’s fine if your fundamental analysis seriously projects a diminution of asset value over your holding period for those assets.

But if you’re selling stocks now because it’s the “right thing to do” unconnected from any investment analysis, you’re forgetting your primary duty.


For “amusement”, check out the California state treasurer bitching about other public pension funds looking after their investment interests:

California treasurer accuses 2 public pension funds of ‘craven greed’ in affordable housing fight

California Treasurer John Chiang on Wednesday slammed two out-of-state public pension funds for what he called a shameful ploy to eliminate 79 affordable housing units in a massive San Fernando Valley housing complex.

At a news conference outside the 390-unit San Regis apartments in Van Nuys, Chiang castigated building owners for asking a judge to end a 55-year affordable housing covenant after only 15 years.

The complex, he said, is owned by the Colorado Public Employees Retirement Assn. and the Utah State Retirement Investment Fund.

“These public funds, which pay their bills on the backs of taxpayers and public servants, should be ashamed of their craven greed,” Chiang said. “Their hubris will deepen the affordable housing crisis afflicting Angelenos. This cannot be done and they’re not going to get away with it.”

The owners filed a lawsuit in October that Chiang said attempts to “exploit an unintended legal loophole” in the company’s contract with the city of Los Angeles to terminate the affordable housing covenants.

“At stake is not only taxpayer funds, but the welfare of hundreds of poor families, seniors and veterans,” said Chiang, who has announced his bid for governor in 2018.

On Monday, the treasurer’s office filed a cross-complaint seeking a court declaration that the 55-year covenant will remain in force. Los Angeles City Atty. Mike Feuer filed a separate cross-complaint Monday, but did not attend the news conference.

Maybe these 55-year-plus covenants are partly the reason you have such a hard time finding affordable housing in L.A., huh? People don’t seem to have these problems in the southeast.

In any case, I am of a mind with John Bury who says the only way to save public pensions is to kill DB public pensions. We can’t trust them [politicians/trustees] to appropriately manage the funds intended to pay the benefits, we can’t trust them to appropriately fund the benefits, and we can’t trust them to keep the benefits from growing out of control.

Calpers, being the largest public pension fund in the U.S., is showing the way.

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